All eyes on the ECB

Emily Nicol

Despite some mixed corporate earnings results, the S&P 500 maintained a steady upward trend yesterday, closing ½% higher. And with little domestic economic news to drive markets, Asian equities similarly eked out gains today – i.e. Japan’s Topix closed 0.2% higher and China’s CSI 300 was up 0.4%. But given reports that North Korea fired short-range missiles into the sea, South Korea’s Kospi fell 0.4%.

In the bond markets, while Asian markets were little changed overnight, there were notable gains in Australia’s government bonds, with 10Y yields declining 7bps to a new record low of 1.23% as RBA Governor Lowe reiterated that the Bank was ready to ease policy further if recent rate cuts fail to revive the economy. And even in the absence of further easing, Lowe added that given the subdued inflation outlook, it was reasonable to expect an extended period of low interest rates.

Having made gains yesterday on the back of some very weak PMIs, European govvies were broadly stable this morning as markets awaited the outcome of the ECB’s latest policy-setting meeting. Politics-wise, Spanish lawmakers will vote today for the second time this week on whether acting Prime Minister Pedro Sánchez will remain in power. If he fails to garner a simple majority Sánchez will have two months as caretaker PM to form a government or face another general election, which would be the fourth in four years. In the UK, meanwhile, focus will be on PM Boris Johnson’s statement to the House of Commons before it rises for summer recess.

Euro area:
All eyes today, of course, will be on the ECB’s policy decision. Despite yesterday’s disappointing PMIs, we expect no substantive policy adjustment today but rather a clear signal that further easing is on its way, probably in September. Certainly, recent comments from Governing Council members have left it uncertain whether they judge that the preconditions for easing policy this month have been met. Indeed, economic data – from the euro area and certain other major economies – have been mixed and difficult to interpret with confidence. And as last month’s forward guidance did not explicitly flag the near-term possibility of a rate cut, we think the policymakers will want to wait for September before deciding what to do. Assuming they wait until then, they would also be able to calibrate precisely their policy response with updated economic forecasts that better reflect recent events.

Of course, given the ECB’s readiness to adjust “all of its instruments, as appropriate”, if and when it eases policy, a range of policy options will likely be on the table – i.e. a cut in the deposit rate, a new tiered interest rate system and more asset purchases. And Draghi is likely to reiterate this range of options in his post-meeting press conference. Indeed, we might well see the Governing Council announce as early as this week an increase in the issue limits on the QE programme (from 33% to 50%) as a signal of preparedness to restart net asset purchases again if necessary. Draghi will also no doubt be asked about the Bloomberg report last week suggesting that the ECB is studying a revamp of its inflation goal.

With respect to economic data, Germany’s ifo sentiment survey is likely to reiterate the extremely downbeat tone of yesterday’s flash PMIs – which showed the headline German manufacturing PMI decline1.9pts in July to 43.1, a seven-year low and signalling sharp contraction in the sector – with the headline business climate indicator expected to fall to its lowest level since November 2014.

After populist Brexiter Boris Johnson was official appointed Prime Minister yesterday, he delivered a predictable ruthless overhaul of the Cabinet with key roles allotted to his fellow pro-Brexit colleagues, including Sajid Javid as Chancellor of the Exchequer, Priti Patel as Home Secretary and Dominic Raab as Foreign Secretary and defacto Deputy Prime Minister. And as the House of Commons prepares to rise for summer recess Johnson will today outline his priorities in his first Prime Ministerial address to MPs. But while this is likely to contain headline-grabbing promises, including not least to deliver Brexit by 31 October with or without a deal, as well as substantive tax cuts and lashings of extra public spending promised throughout the Conservative leadership campaign, we anticipate a continued lack of any meaningful insight into how these will be delivered. And with the House not set to return until 3 September, this would leave just over eight weeks to complete what May’s government was unable to achieve in the past three years.

Beyond any political news, this morning will bring the CBI’s latest Distributive Trades survey, which will give a health-check on the retail and wholesale sectors in July. This is expected to show a notable pickup in the headline retail sales indicator, albeit still pointing to ongoing weakness in the sector. Although it should be noted that this survey failed to tally with growth in the official retail sales figures last month.

In the US, ahead of tomorrow’s Q2 GDP estimate, the focus today will be on the advance goods trade and durable goods orders data for June. While the value of exports and imports are expected to be weaker that month following the surge in May, a large drop in exports in Q2 will likely suggest that net trade was a drag on GDP growth last quarter. And while manufacturing orders are likely to be stronger in June, this follows considerable weakness in the previous two months. This afternoon will also bring the Kansas Fed manufacturing activity index for July and the latest weekly jobless claims figures.


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